I HOLD THIS TRUTH TO BE SELF-EVIDENT, THAT A DEBT CRISIS CANNOT BE RESOLVED WITH MORE DEBT

Monday, September 19, 2011

Debt and The Second Law

A very short post today.

Debt is a call on future earnings, i.e. it presumes there will always be economic "growth" (however you may define it) in order to produce those future streams of income which will service the debt. This is a condition I have called "Permagrowth".

But is it possible?

In the "real" world, where physical fact always trumps populist monetary neo-theology, Permagrowth is impossible by definition. The Second Law of Thermodynamics reigns supreme, i.e. there is no perpetual motion machine - and can never be.

The entropy of the universe tends to a maximum is the "classical" expression of the Second Law, so I come up with a corollary: as the universe always tends to disorder, so debt always tends to default.

In other words, since Permagrowth is impossible so is Permadebt.

P.S. My blog is getting the attention of "comment advertisers", i.e. advertisers who hawk their wares under the guise of "I love your blog" comments. Par for the course, of course, and I usually quickly clean up the comment section. What is interesting, however, is that lately they are hawking gold, gold market tips, etc. Nice contrarian signal, in my opinion.

P.P.S. Speaking of such ballistic charts, in a post four years ago (South Seas and China Seas) I posted the following chart, comparing the famous South Seas Bubble with the price of a (then unnamed) shipping company.

I did not mention the name of the company at the time because I felt it should not be singled out in what was, after all, an industry-wide bubble. Nevertheless, some readers immediately identified the company as Dryships, a bulk-carrier shipping company.

Four years later, this is what happened.

Other than self-congratulation, my point is pretty simple: beware of all bubbles, no matter how "logical" they seem at the time. In fact, the more "logical" they appear the closer they are to bursting.The devil, as always, is in the timing, of course...

16 comments:

That 2nd Law! I am in a MA class, taking a module, 'International Financial Crisis'. I'd be better off reading your stuff, seriously.

Anyhow, we had a 'discussion' to-day - about a book, Bad Samaritans (Chang). I innocently asked about the author's economic Model-in-Use. Its not specifically metioned, but it appears to be Permagrowth. When I mentioned the term all I got were blank stares (2 faculty, 24 postgrads). I then asked about Albert Bartlett. More blank stares. Then I asked who were the engineers and scientists in the room. One of the faculty said he had an engineering background. So I said, "that 2nd Law ... ...?"

When even one of my big group of friends buys gold, then I might agree that we are in a bubble. As of today, they still just laugh. Moreover, something like .1% of all investment dollars are in gold. When that is 10% or more, that could be a bubble.

I would bet that a chart of M2 also looks like a bubble. My bet is that it will continue.

You are not taking into account 'value'. As debt increases and the money supply increases, the call on the future physical world does not necessarily increase as that depends on 'values' which are reduced by their very increase, if you see what I mean.

What more debt really means is that some people are getting more wealthy as some are labouring under more debts. It's a reflection of imbalances between trading entities whether they be individuals (rich and poor), countries (Greece and Germany, USA and China) or companies and people say.

When the imbalances get too big, demand falls. There are only a litmited number of ways to correct imbalances - default, fiscal transfers or indeed the creation of even more debt to devalue existing debt....as long as the indebted's debts on the whole are devalued whilst savings are too in order to redress those imbalances.

Gold will not collapse as bubbles do if the world returns to a gold standard.

In following with your permagrowth critique - what is more conducive to impossible permagrowth: keystroke money or gold?

I believe the 40 year experiment in pure debt issuance for settling (im)balances of trade and consumption is nearing its end.

Yes, there are a lot of snakeoil salesmen hawking gold recently - and that happens for all asset classes, but that doesn't take away from the fact that central banks, on the whole, never got rid of their gold, and are net buyers now.

I am not bearish or bullish, per se, on gold. I am a gold agnostic when it comes to its use as a monetary base, or anchor. In this, I fully subscribe to Keynes' view: it's a barbarous relic.

That being said, its price chart does look scary, the blathering masses are talking it up like crazy, the world is running out of vault space (search for the Bloomberg story today).... and there is a VERY convincing fundamental reason to own gold.

Yes, it would be nice to get a crash in gold. I am looking forward to that, because I have not bought as much as wanted when gold price was way below. On the other hand, none of the suckers I know has bought any gold.

Hell, you inspired me to post on the Hell-spawn site . No market, no point in dollars or gold. Social stability needs to be considered.

Greenie, we seem to remember Thai very differently. He could disagree in a civil, even amiable, manner. He often defended Hell (and pretty much everyone else) from your pointless ad hominem attacks. I distinctly recall him once telling you to "stop being a putz". C'mon, disagree in a way that encourages discussion instead of making people want to leave.

About Me

I was educated as a chemical engineer but spent almost my entire career in finance, particularly in money, FX and bond markets. The name stands for Hell-as-IOUs and the picture points to Quixotic endeavors.